In this problem, we consider replacing an existing electrical water heater with

Question

In this problem, we consider replacing an existing electrical water heater with an array of solar panels...

In this problem, we consider replacing an existing electrical water heater with an array of solar panels. The net installed investment cost of the panels is $1,080 ($1,800 less a 40% tax credit from the government). Based on an energy audit, the existing water heater uses 180 kilowatt hours (kWh) of electricity per month, so at $0.13 per kWh, the cost of operating the water heater is $23.4 per month. Assuming the solar panels can save the entire cost of heating water with electricity, answer the following questions a. What is the simple payback period for the solar panels? b. What is the IRR of this investment if the solar panels have a life of 10 years?

Explanation / Answer

Monthly savings = $23.4

Annual savings = $23.4 x 12 = $280.8

(a) Payback period (PBP) is the time by when cumulative net cash flow is zero.

PBP lies between years 3 and 4.

PBP = 3 + (Absolute value of cumulative cash flow in year 3 / Cash flow in year 4)

= 3 + (237.6 / 280.8) = 3 + 0.85

= 3.85 years

(b) IRR is computed using Excel IRR function as follows.

Year Cash Flow ($) Cumulative Cash Flow ($) 0 -1,080 -1,080 1 280.8 -799.2 2 280.8 -518.4 3 280.8 -237.6 4 280.8 43.2

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